Inflation and Mortgage Rates
The Fed lowered rates by a staggering 50 bps at its last meeting. The markets largely expected this move, as did we. The next two Fed meetings decisions are still debatable. The November meeting is 2 days after the election, and we expect rates to drop 25 bps if Harris is elected and flat on a Trump election. If the election results are not finalized by the Fed meeting, a 25 bps cut is most likely.
The biggest question mark on most people’s mind is why did mortgage rates rise when Fed rates were lowered by 50bps? Let me explain.
Mortgage rates are a spread relative to 10 year treasuries. The Fed rate is the overnight window (short-term rates). Though Fed rates have an affect on 10 year bonds, they are not always correlated. In this case, lower short-term rates after the September FOMC meeting balanced the deeply inverted yield curve:
The spread between the mortgage rates and 10 year treasuries is measured by risk the banks expect to take by issuing loans. A lower fed rate is inflationary, creating more risk to borrowers. How? Higher inflation and lower wage growth makes many everyday items such as groceries are unaffordable, causing consumers to rely more heavily on credit. Consumer credit, and the risk associated with it, has risen and is expected to move higher as consumers use credit cards to pay for food. A recent earnings report from Walmart showed individuals in lower-income demographics are spending less, but Walmart still had an increase in sales, largely due to those in higher-income demographics focused on bargain-shopping.
We have a reasonable expectation of another 25-50 bps of rate cuts through the end of 2024, with another 50-100 bps of cuts in 2025. Though this is good for short term corporate credit, and even consumer rates (like credit cards and auto credit), this may not translate to lower mortgage rates.
Inflation remains persistent due to high government spending. The US interest rate expense from the debt issued to fund our government spending now exceeds military spending for the first time. In addition, global inflation will continue to rise. The UK has not lowered interest rates below 5.0% as they are still teetering with high inflation, despite an economy that is the ropes. Chinese consumers have run out of Yuan to spend, causing a disinflationary environment for the Middle Kingdom. To battle this, the PBOC has cut bank reserve requirements by 50 bps, target interest rate by 20 bps, and mortgage rates by 50 bps last month. Additionally, the PBOC has provided $113B to investment firms to buy domestic stocks.
China is the economic leader of the BRICS nations, with the Renminbi as a central currency. Given expected inflation from these initiatives, expect the cost of commodities to rise. Not only is gold up 10% since September, but so is copper, iron ore, and other mined commodities.
This will turn into an everything rally: Stocks, bonds, crypto. But government currencies will continue to be worth less.
